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Oaktree Capital Group LLC (NYSE:OAK)

Q4 2013 Results Earnings Conference Call

February 13, 2014 11:00 AM ET

Executives

Andrea Williams - Head of IR

Howard Marks - Chairman

John Frank - Principal Executive Officer and Managing Principal

David Kirchheimer - Chief Financial Officer

Analysts

Michael Carrier - Bank of America

Matt Kelley - Morgan Stanley

Michael Kim - Sandler O'Neill

Chris Harris - Wells Fargo Securities

Brian Bedell - Deutsche Bank

Ken Worthington - JP Morgan

Danielle Matsumoto - Goldman Sachs

Operator

Welcome and thank you for joining the Oaktree Capital Group Fourth Quarter 2013 Conference Call. Today's conference call is being recorded. At this time, all participants are in a listen-only mode, but will be prompted for a question-and-answer session following the prepared remarks.

And now, I would like to introduce Andrea Williams, Oaktree’s Head of Investor Relations, who will host today's conference call. Ms. Williams, you may begin.

Andrea Williams

Thank you, Ivan. Welcome to all of you who have joined us for today's call to discuss Oaktree's fourth quarter and full year 2013 financial results. Our earnings release issued this morning detailing these results may be accessed through the Unitholders section of our website.

Our speakers today are our Chairman, Howard Marks; Principal Executive Officer and Managing Principal, John Frank; and Chief Financial Officer, David Kirchheimer. We will be happy to take your questions following their prepared remarks.

Before we begin, I want to remind you that our comments today will include forward-looking statements reflecting our current views with respect to among other things, our operations and financial performance. Important factors could cause actual results to differ, possibly materially, from those indicated in these statements.

Please refer to our SEC filings for a discussion of these factors. We undertake no duty to update or revise any forward-looking statements. I'd also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in any Oaktree fund.

During our call today, we will be making reference to certain non-GAAP financial measures which exclude our consolidated funds. For a reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure, please refer to our earnings press release which was furnished to the SEC today on Form 8-K, and may be accessed through the Unitholders section of our website at www.oaktreecapital.com.

Additionally, references to amounts per Class A unit are after taxes and other costs borne directly by Oaktree Capital Group. Today we announced a quarterly distribution of $1 per Class A unit, payable on February 27th to holders of record as of the close of business on February 24th. Finally, we plan to issue our 2013 Form 10-K on February 28th.

With that, I would now like to turn the call over to Howard Marks, who is joining us from New York.

Howard Marks

Thank you, Andrea. Hello everyone. We’re pleased to report continued strong financial performance including record annual revenues distributable earnings and distributions to our unitholders. As was the case in 2012, this performance was the result of solid investment returns and a robust cycle for realizations and distributions driving strong incentive and investment income proceeds. It’s easy to describe 2013’s investment environment in general stocks did much better than bonds, low quality assets did better than high quality assets, U.S. assets did better than non-U.S. assets and fund raising got easier in alternative markets.

Stocks and bonds moved in opposite directions during the year fueled by an accommodated fed and an improving economic outlook equity stays there remarkable rally. The S&P 500 sky-rocket and high popping 32% while treasuries were pummeled the same year benchmark note was 8%. A mid concerns about higher interest rates and the winding down of quantitative easing.

As for high yield bonds, they [handly] outperformed high grade by 950 basis points proving once again to be much less vulnerable to rising interest rates than their higher quality counterparts. Investors’ thirst for yield drove significant capital flows into the leverage debt markets specially on the senior loan side. There was a pervasive feeling as the year progressed that the U.S. economy was gaining strength and was the best house on the bad block.

In essence the markets didn’t clime the wall of worry in 2013 as they had in ‘12 rather they became less worried and more confident, thus risk conversion receded in response to low interest rates and the big gains in equities and other risky assets.

Against this backdrop of prorisk behavior and bullish equity markets obviously strong investment performance for the fourth quarter in all of 2013 may surprise you but it doesn’t surprise me or our clients. Our investment approach is designed to capture much of the upside while protecting clients and capital on the downside.

The past year was an opportunity for us to demonstrate the former and I think our investment teams did that well. Our closed end funds averaged a 22% gross gain for 2013. We distressed that at 24%, global principal at 21%, European principal at 22%, our opportunities at 32%, mezzanine at 20% and real estate at 16%. As of year end 2013, all 47 of our incentive creating closed-end funds more than year old had positive gross IRRs since inception. And 41 of those funds were at or above the 8% net IRR level which is generally the maturing threshold, we must exceed to earn incentive allocations.

How can affirmed known for specializing in credit and distress investing achieves its strong result and a year generally got as great equities and poor for debt. We did it by capitalizing on what we call the power of credit. And one benefit of credit investing is the promise of repayment. We are very happy to have that promise fulfilled when it is, but we are also happy if it’s not and we have the opportunity to convert debt into equity at attractive evaluations.

Last year we capitalized on rising asset prices in accommodative markets to generate $12 billion in distributions to closed-end fund investors bringing the two year total to almost $25 billion. In the fourth quarter alone, noteworthy IPOs sales or other realization events included our holdings in Stock Spirits group, Campofrio food Group, Techniflex and Nine Entertainment.

On the closed end investment side, we continue to find the best opportunities in global real estate, Europe and shipping. Although core real estate which is not our focus as substantially recovered, we continue to find opportunity in number of other areas including non performing residential and commercial loan pools and commercial properties in non-core markets.

In Europe our substantial 15 year presence enables us to benefit from the space created by diminished mainstream bank lending. Our European principle team has been particularly active in building platform investments in sectors such as residential development, retirement living and student housing.

Finally shipping which has been a focus of our distressed debt and principle investing teams for almost 20 years is typical of the sort of cyclical capital intensive industry that affords us some of the best opportunity. Over the last couple of years, we've invested in shipping in a number of ways, in each instance taking advantage of the opportunity to supply capital at a depressed point in the capital cycle from purchasing new vessels to purchasing loans secured by ships from European banks to purchasing the distressed debt of shipping companies.

Global shipping demand trends now appear to be improving and we’re well positioned to benefit. This is another in a long series of instances of our finding opportunities in out of favor capital incentive industries, when everyone else says, no way. For our open-end fund, years in which risk bearing is rewarded like 2013 can present the challenge for Oaktree given our funds emphasis on risk control.

Nevertheless we did quite well. With the majority of our marketable securities portfolios matching or outperforming their benchmarks and with aggregate net inflows reach $1 billion for the year. Our U.S. high yield bond strategy serves as a good example. In 2013 the riskiest bond rate a CCC, averages a total return three times as high as their better quality DD counter parties. Thus because we down play CCCs, we started out at a disadvantage versus the benchmarks. Nevertheless our credit selection skill overcame that disadvantage enabling our composites growth return of 7.1% before fees, which translates into 6.5% after the max that of the index.

In European high yield bonds we returned 10.6% before fees and 10.1% after, out [businessing] the index and contributing to solid outperformance in our global high yield bond strategy, which beat its benchmark by 140 basis points for the year. Our new emerging markets, equity strategy, which we call EMES continue the solid performance in 2013 in a very tough market. Our 1.8% positive return before fees and 0.9% after was 440 basis points ahead of the index. We saw strong inflows in the fourth quarter, which John will discuss later.

Finally, our newest evergreen fund strategy, strategic credit, which folds between the stress debt and high yield bonds on the risk return curve at a terrific start with an 18% gross returned. With $2 billion amassed in just 18 months for the strategy, strategic credit fills an attractive risk rewards base in Oaktree’s industry leading line up of credit products.

Looking forward, we expect to follow the same mantra we have employed over the last two plus years, move forward, but with caution. I believe that posture is highly appropriate for today’s markets and economies and it positions us to continue delivering strong returns, while protecting our clients’ capital.

The past year is a source of great pride for me and for the Oaktree team, especially the strong investment performance and the continued growth of our franchise even as we harvested sizeable investment gains for fund investors.

Importantly we continue to maintain our discipline in sizing funds to the opportunity set, focusing on selective product developments in areas where we had expertise and maintaining our reputation with our 2,000 clients as the dependable purveyor in our alternative asset classes.

And with that I’ll turn it back to Los Angeles and to John Frank.

John Frank

Thanks Howard. Hello everyone. The fourth quarter marked another period of solid performance by our investment teams, a continuation of record financial results and a particularly strong period for fund raising. We raised gross capital of $4.1 billion in the quarter and $12.5 billion over the last 12 months. That makes 2013 our severance great year of raising $10 billion or more and the best year for fund raising that didn’t include new capital for distressed debt.

Our fund raising kept pace with a near record level of realizations and distributions that Howard discussed, driving our total AUM up 5% for the quarter and 9% for the year to $84 billion. Importantly, fee generating AUM grew 7% in the fourth quarter to a record $72 billion.

It’s worth noting that at year-end 2013, our total AUM was approaching the quarter-end record of $86 billion set in March 2011. That record figure from three years ago included $18 billion in Opps VIIb, which was down to $3.3 billion at this year-end.

Strong demand from our clients has allowed us to almost make-up for the loss for that loss of $15 billion from Opps VIIb over the last three years. With the process of liquidating Opps VIIb in the late stages we think we’re well positioned for further growth. New clients and new products were key elements in our asset growth during the year, as 40% of the $12.5 billion of capital raised in 2013 was for strategies and investment products that didn’t exist three years ago and one-third of the capital raised was from investors new to Oaktree.

When we undertook our IPO, some question whether Oaktree was more than a distressed debt manager and if our prospects for growth were limited particularly given the recovery in economy and our express preference for organic growth over acquisitions. I think our progress since then shows that the strength of our franchise goes well beyond distressed debt and that we are well positioned to continue to add new strategies and grow our business whatever the prevailing market environment. We have plenty of runway.

We are just beginning for instance to grow our senior loan strategy. All told, we manage about $6.5 billion in senior loans today. But at $1.8 trillion the market for U.S. and European senior loans is as big as the market for high yield where we manage about $20 billion, as you can see we’ve got plenty of room to grow. Similarly, we see great opportunities for growth overtime in emerging market equity and debt.

In the case of emerging market equity, we’re anticipating adding $2 billion in management in the first half of this year. And we are not going to add that degree of capital that quickly to emerging market debt, but overtime we think our emerging market debt strategy may will become one of the most substantial parts of our business.

As Howard mentioned, we are seeing excellent investment opportunities in real estate. Taking advantage of a broad mandate of many of our closed-end funds, we’ve invested over $7 billion in real estate in the last two year not just through our dedicated real estate funds, but across many of our closed-end strategies. Those investments have helped bring our newest closed-end funds in real estate and distressed debt to 40% and 35% drawn respectively, suggesting that new fund raising for these strategies may not be too far off.

Now I would like to briefly review what we accomplished over the last year and where we are headed. Our focus of course is always on our clients. What is it we can do better than most to offer our clients achieve their investment goals? As it happens, notwithstanding the low interest rate environment, our focus on credit is helping our clients achieve the returns they need with the risk control they require.

We have added $2.5 billion in the last 12 months to our open-end and evergreen strategies, bringing their aggregate AUM to a record high. What’s accounted for that success? First, the continuing appeal of our high yield strategy in all of its forms U.S. European and global, second, the development of our U.S. and European senior loan strategies where our AUM has increased 76% to $6.5 billion this year, third, the extraordinary success of our new strategic credit strategy, which Howard has only referenced and fourth the growth for emerging market equity strategy which I will detail in just a moment.

In addition to developing new strategies to take natural advantage of our existing expertise, we are also focused on broadening our distribution channels. In November 2013 for instance, we became a sub-advisor to the Northern Trust Emerging Markets Equity Fund. And we partnered with Harbor Funds to launch the Harbor Emerging Markets Equity Fund. Together, these relationships have already added $500 million of gross inflows, while expanding retail investor access to our emerging market equity strategy.

Leveraging those new relationships and our strong relative investment performance, we saw $900 million of new capital for emerging market equities in the fourth quarter. This year we anticipate raising more capital for strategic credit, which gives support has been limited to nine digit institutional separate accounts through the formation of a co-mingled fund for institutional investors.

We’ve also just launched a second enhanced income fund, which like its successful predecessor that we raised last year will invest in senior loans in a modestly leverage bases. We have already had a strong client response and we expect to hold the first closing for this fund in April. We expect the total fund size to be $2 billion and that we’ll do that this year.

Moving on to our traditional strategies, we’ll be raising new capital this year for our new Principal Fund VI and our new Mezzanine Fund IV. As I indicated on our last call, we’ve slowed the fund raising for Principal Fund VI given that we already have plenty of capital on hand in our existing fund. We expect we’ll focus more on Principal Fund VI in the second half of the year.

We’ve just launched our new Mez Fund IV and are excited to continue to build upon our long record in the mezzanine space. Given that we’re just getting into the marketplace, I won’t forecast the size of the fund and the timing of the fund raise, but we do anticipate that the fund will be comparable in size to its $1.6 billion predecessor.

In real estate, fund raising continues to go well for our new debt fund, which currently has $500 million in commitments, in which we anticipate to be over a $1 billion by mid-year. The successor to our PPIP mandate utilizes the skills of the existing real estate team to invest in real estate debt securities offering a net return in the high single-digits, too low for our real estate opportunities funds, but still appealing to investors seeking yields.

Finally I’ll mention that many of you know that in December of last year we became a cornerstone investor in the IPO undertaken by China Cinda Asset Management. Cinda is the premier distressed real estate manager in China and we’ve announced our mutual intention to create a joint venture to pursue distressed investment opportunities in China. While it’s too early to make predictions, we’ve relocated one of our real estate professionals to Beijing to lead the joint venture from our side and we’re excited to develop this unique access to the enormous Chinese market.

Looking forward, our plan over the next couple of years is to continue to build upon our strengths, while maintaining our investment and business discipline. We see great opportunities to continue to grow organically and at the same time we remain open to strategic transactions that will enhance our ability to serve our clients in the same dependable risk conscious fashion as has been our history.

We never forget that our strong earnings and cash flow are the products of our investment success and our clients’ confidence in us. Our focus is and always will be on our clients. We are sure that that’s the best recipe for maximizing the value of our enterprise.

With that I’ll turn the call over to David to address our financial results in more detail and then we’ll look forward to your questions. Thank you.

David Kirchheimer

Thanks John and hello everybody. A year ago, I summarized the fourth quarter of 2012 as representing a record quarter in a record year. That was a tough act to follow. But here we are a year later and I’m again delighted to report sizable year-over-year gains including a record high for full year distributable earnings.

Moreover, 2013’s record high cash flow was comfortably exceeded by adjusted net income as mark-to-market investment income was 57% higher than realized investment income proceeds, coupled that achievement with the fact that our gross incentives created of $1.2 billion exceeded the year’s record $1 billion in gross incentive income.

And you can see that our investment teams were creating enormous value even as a continued harvesting record recovery cycle realizations. We view that value creation as restocking the pond for future income.

Let’s go to the results, starting with the fourth quarter, when adjusted net income grew by $48 million versus the prior year’s fourth quarter to $268 million or $1.62 per Class A unit. Distributable earnings came in at $221 million or a $1.33 per Class A unit. The $47 million access of ANI over distributable earnings reflects the fact that we created value in the form of mark-to-market investment income at a greater level than what we were realizing in the form of investment income proceeds. Economic net income was a still higher $303 million or a $1.92 per Class A unit, reflecting in aggregate $82 million access of value creation over cash realization for investment income and net accrued incentives.

Management fees in the quarter benefited from the final closing of Real Estate Fund VI and other capital inflows, somewhat offset by the fact that Opps IX was still paying management fees based on drawn capital which averaged 27% for the quarter. Incentive income in the fourth quarter rose principally from Opportunities Fund VIIb, Principal Fund III and annual incentive fees from Value Opportunities Fund.

Annual period comparisons are similarly impressive in terms of both cash flow and value creation. Starting with cash, distributable earnings reached a record $984 million for 2013, or $5.82 per Class A unit, up 52% from 2012’s record $3.82. Adjusted net income was even greater at almost $1.1 billion or $6.38 per Class A unit, up 57% from the prior year’s $4.06 and a new record high, while economic net income came in at over $1 billion or $6.07 per Class A unit. In all three cases, 2013 strong incentive and investment income gave rise to relatively low income tax rates.

We’ve now had 16 consecutive years and 40 consecutive quarters of positive incentive income with the cash flow to show for it and never a subsequent clawback. The creation of potential future incentive income continued through 2013 with the fourth quarter representing the second highest of the year. For the full year, 31 different funds across eight different investment strategies created incentives.

Added all up, and we finished 2013 with accrued incentives net of compensation of $1.2 billion and unrealized investment income of nearly $400 million, their total $1.6 billion of unrealized profits before taxes was slightly higher than the corresponding total at year end 2012 as value created more than kept pace with 2013’s record levels of realized incentive and investment income. Plus, the $1.6 billion represents over $10 for operating group unit of potential future distributable earnings. And that’s before considering fee related earnings, our share of DoubleLine’s income, other income and expenses and of course future incentives created and investment income.

That said, it’s important to note that the prospect of near-term realizations from the year end 2013 accrued incentives balance is considerably lower than was the case a year ago. Specifically of the $1.2 billion in net accrued incentives fund level as of December 31, 2013, nearly $500 million represented funds that are currently paying incentives with the remainder arising from funds that as of year-end hadn’t yet reached the stage of their cash distribution waterfall where Oaktree is currently entitled to receive incentives other than tax related distributions. A year earlier again in 2012, the equivalent portion of net accrued incentives that was paying incentives was $800 million. Of year end 2013’s $500 million, Opps VIIB represented about forfeits. And as we’ve often noted, incentive distributions tend to become lumpier, less frequent and/or smaller in size, the further closed-end fund progresses through its liquidation phase, such as now is the case Opps VIIB.

Thus looking only at year end accrued incentives fund level, in 2014 this revenue source would be expected to generate lower distributable earnings and adjusted net income in the form of net incentive income than was the case in 2013. With respect to the creation of new accrued incentives, it’s noteworthy that the amount of our incentive creating AUM that was creating incentives as of year-end 2013, reached $29.6 billion, up 16% year-over-year.

Shifting back to 2013, it’s important to recall that one of the many attractive volatility damping aspects of our business model is the roughly complementary relationship between our two biggest revenue sources, management fees and incentive income. For example, in a recovery phase of the economic cycle, rising incentive income from closed-end funds in their liquidation period often counter balances declining management fees from those same funds.

If ever there was a year when our total management fees would have been expected to drop, 2013 was it. After all in addition to unilaterally delaying the start date of Opportunities Fund IX, there was a reduction of $14 billion in management fee generating AUM, as a result of the past two years $25 billion of closed-end fund distributions that Howard mentioned.

But even with those twin headwinds, management fees held their own at about $750 million for both 2012 and 2013, thanks to continued strong fund raising, product development and market value gains. And with the investment period of Opps IX, having started as of January 1, 2014, total fee generating AUM, a forward looking metric, reached a record $72 billion as of year-end 2013. Moreover, the portion of that $72 billion paying management fees based on NAV, reached its own record high of $39 billion, up 19% for the year. Thus positive returns will boost that category of management fees more than ever before. And when markets move downward, increased capital for distress oriented funds could very well mitigate declines in NAV based fees.

Fee related earnings remained solid at $260 million in 2013, even as we invested in new products and our global infrastructure and as we addressed the array of post crisis regulatory requirements. Additionally, our A rated balance sheet strengthened further as we continued to build our capital base and access to liquidity. Here again 2013 was a record year including with respect to cash balances and book value. Our financial strength enables us to see new products without impairing equity distributions. This blend of internal growth and external investment reflects our ability to capitalize on a broad range of opportunities to expand the Oaktree franchise.

Finally, let’s look briefly at the current first quarter which is underway. Based on known fund distributions so far in the first quarter, distributable earnings from net incentive income and investment income proceeds total an estimated $15 million. We also expect to recognize incentive income this quarter from tax related incentive distributions paid by funds that generated taxable income in ‘13 but aren’t yet paying normal incentives. It’s too early to make a reliable estimate, though initial indications are that net incentive income and therefore distributable earnings from tax related incentive distributions will likely be at least in the $55 million to $60 million that was the case in 2013’s first quarter. With respect to Opps VIIb it had additional income and asset sales since the fund’s last distribution which was in November.

As of now, the fund has upwards of $250 million of available cash though the timing and amount of Opps VIIb’s next distribution to investors including incentive income to Oaktree are unknown.

So wrapping things up, 2013 served to just a latest example of the adage that was good fund investors is good for Oaktree unitholders. But while adage is old, the potential is new, because we are now able to build on that success, with a product development capability, financial strength and global for Intel that we believe are stronger than ever.

And with that we look forward to answering your questions. Ivan please open up the lines.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question today is from Michael Carrier from Bank of America.

Michael Carrier - Bank of America

Thanks guys. First question just on the fund raising outlook, it’s another strong quarter, strong year, pretty much across products and while the new products that you highlighted. I guess like two questions. You mentioned more activity on the sub-advised part of the business, just want to get a sense like is there a pipeline there meaning are there more conversations given your expertise in this area given your performance in some firms winning the outsource that you guys? And the other would be just you mentioned emerging market as a potential long term opportunity, is there any issue there in terms of institutional clients, the amount of money they’re willing to allocate to that asset class versus where you see the potential opportunity or is it more like a market share gain? I mean you feel like there is a lot of opportunity for Oaktree to move into that space given your expertise and take share from other players.

John Frank

Hey Michael. So with respect to the first question about the sub-advisors we now have 5 or 6 I am not sure the exact number sub-advisory relationships, of course the most significant of that is with Vanguard where we sub-advised and have for many, many years sub-advised their convertible strategy. And also we’re one of the managers of their actively managed emerging markets equity strategy.

We would like to do that with more firms and we are talking with others, even sub-advisors have terrific relationship because we get to manage the money which is our expertise and the mutual fund company or whoever it is that we’re sub-advising manages all the rest of the operation, which is not to say we’re not prepared to launch our all mutual funds that is something we’re thinking about as well. But we’re excited about the sub-advisory relationships we have and I think they’ll continue to grow.

In terms of the emerging markets you’ve got a number of very positive trends I think to benefit us. One as the emerging markets grow there is greater opportunity and obviously it’s no secret that the emerging markets are developing. Two, you do have clients who have and want to continue to make allocations to the space. And so they’re looking for dependable managers to manage money in the space and in a number of these areas there are not a large number of capable competitors that have the kind of scale in size and resources that we have. So we think we will benefit as we move forward both from market share as you put it and also from the fact that the market is benefiting from what we think are significant growth trends. So we think we’ll benefit both ways.

Howard Marks

Since it’s a good story, I would like to put in a few words. Emerging markets are one of the few markets in the world today that are statistically cheap. Now you can argue that they are statistically cheap for a reason which is that they face considerable uncertainties and nobody can deny that. But I think people are attracted to their attractive valuation levels and as John says that there is a small number of managers who have added value over the years. We started to manage loan only emerging market equities two and half years ago and we have consistently added value substantial in amount and we think we can continue to gain assets.

Michael Carrier - Bank of America

Okay that’s helpful color. And maybe a follow up, on maybe David, just when we think about some of the comments that you made on the outlook distributions and I think you gave sort of that roughly $500 million your number that could be paid out versus the $1.2 billion accrued incentives. I guess when we think about that the delta like the $700 million are there any funds that you would point out that are closer to kind of getting to that level of paying? I know we can kind of look at it on the fund table, but just any color on that in terms of the outlook of that $500 million number growing over the next 12-18 months?

David Kirchheimer

Sure. So Opportunities Funds VI and distressed debt you will see at the fund table is one of those that in the $700 million therefore not yet currently paying incentives that is certainly moving closer. And thanks to best pace of utilizations and distributions you can see against the fund table, other examples of the funds moving towards that. In the meantime of course, strong markets and the fact that there is a heavy amount of this level III in private holdings in the more mature funds also creates the potential for gains in that $500 million portion as well. So it’s not as if that bad amount is frozen in time. And so for both sides we would certainly have the potential for further gains in that number.

Michael Carrier - Bank of America

Okay, thanks for the color.

David Kirchheimer

Thank you, Michael.

Operator

Thank you, our next question is from Matt Kelley from Morgan Stanley.

Matt Kelley - Morgan Stanley

Good morning, guys. Just following up on Michael’s last question actually David when you gave some of that guidance and you just talked about Opps VI. I am just curious are there any other funds in your perspective, when you look into 2014 and 15 that you think there are some lumpy level III assts that could become less, actually more liquid and help those unwrittened drawn capital book for the accrued preferred return numbers and any specific funds outside of Opps VI which you would highlight for us?

David Kirchheimer

Sure, well, thanks Matt. First this is one I guess, I get to be the first person on the call to say that our crystal ball is no better than yours. And so I wouldn’t want to suggest that there is any certainty regardless of the level type of the asset in terms of which fund is going to next sort of move up in the queue to paying incentives.

Couple of thoughts. First let’s not forget the evergreen funds, for example value opportunities which was a big contributor of the fourth quarter incentive income and that as assuming positive returns, a annual source of incentive income. There is also ongoing, the part of the coupon, also creates income regardless of the level of the -- level type of the holding. So across the portfolio for example, in 2013 we had 6.4% current yield on just the debt portion of the closed end funds and so again that's regardless of the type of security.

But assuming that the capital in financial markets remain strong in the other distress debt funds and in Principal Funds we’re continuing to see real estate. You’ve already got Principal Fund III, Real Estate Fund III for example that are currently paying incentives and the funds behind them are moving forward.

But I would not want to a make our prediction now in terms of the exactly what the pace of selling is. Our PMs are going to continue making the best decisions they can. And what in the meantime to the extent that they decide to hold that assets, well of course management fees benefit. So there is that benefit in the meantime.

Matt Kelley - Morgan Stanley

Yes, that's helpful. And then I wanted to come back to the emerging markets topic a little bit because obviously that's an area of increasing focus for you guys both debt and equity and now the investment in Cinda. So I just be curious when you think about other opportunities for different asset classes in emerging markets that you are not currently managing that you think you potentially could whether it be real estate or control investing, are there any of your existing strategies that you think you can kind of use to create more of an umbrella for emerging markets as an overall strategy for the firm?

John Frank

Well, I don’t know what Howard supplement, but I would just say Matt. We are just beginning to scratch the surface in equities and in debt and we can, we’re thinking about doing both distressed debt, where we've already formed a fund which is rather $850 million and we’re just beginning to invest it. And in performing debt, which were beginning to look at and beginning to touch our toe into. And these can be enormous markets.

In real estate we’re not particularly doing anything right now. But obviously we could, but I guess what I would say is this is a huge market that we’re just beginning to get into. So I don’t think we need to be too worried about product proliferation if you will, if we just stick to those kinds of things, we know how to do well, distress debt, more performing debt, the equities that we have been doing since the leap 1990s will be very, very well and we’ll have plenty to do for long time.

Howard Marks

Yes. And I would just add that for a long time I was hesitant to go into Asian debt for example because our emerging market debt, because most of the debt was sovereign. And I’m always worried that financial analysis of sovereign debt is an option moron. Now there has been a lot of corporate issuance and I think corporate EM debt exceeds for example the U.S. high yield bond market in size. So I agree with John, there is a lot to do and we really have barely scratched the surface.

And taking our existing capabilities to the emerging markets leaves us a lot of runway.

Matt Kelley - Morgan Stanley

And then just one last follow-up from me, the emerging markets equity fund, you gave helpful color on the $2 billion for the first half of the year, so I appreciate that. But as you get to the back half of the year, correct me if I am wrong, you’ll be getting a three year track record for that. And so, I am just curious do you think that could actually -- obviously you’ve a number of kind of lumpy wins in the first half of the year, but I would think that more institutions will be assuming the performance holds up will be attracted to that performance as well in the back half of the year. Is that fair or am I thinking about that wrong?

Howard Marks

No, I think you’re exactly right. I think that as to any particular quarter or period you know as much about it as we do. We’re going to be selling this in the fourth quarter to people who we haven’t even said hello to yet. But I am just very convinced that the combination of the attractive valuations, the capabilities of our team and the record we’ve achieved over the last 2.5 years will stand us in very good stat. And this is an area where two years ago it was a splinter and two years from now it could a really sizeable growth. So, we’re all hopeful, I’m hopeful that what you said becomes true. And I am very optimistic that it will.

Matt Kelley - Morgan Stanley

Okay. Thanks very much guys.

John Frank

Thanks Matt.

Operator

Thank you. Our next question is from Michael Kim from Sandler O'Neill.

Michael Kim - Sandler O'Neill

Hey guys good afternoon. First, can you maybe just give us an update on how you are thinking about sort of the buying versus selling environments for the distressed business particularly in light of bringing Opps IX online? So, just wondering if that needle has shifted a bit more recently and what the implications might be as you think about the trajectories for both realizations and deal flow?

Howard Marks

I don’t think that the decision to start the fee, official fee period on Opps XI is indicative of an increased supply. The immediate reason why we did it is that we reached a sufficiently invested status where you see the problem with fees in the beginning is that we have the ability to charge fees on all of the committed capital, but we only make money on the invested capital. And if there is a very, very large difference between the two then the fee is a fund that’s heavily burdened with management fees. If we’re charging on $100 and we are earning money on 10, it’s hard -- the difference between gross and net fees returns become enormous. So, it funds about a 100 about 50% committed for investment. And we’ll invest the rest over the coming quarters. And we made a judgment that delaying last year was the right thing to do and starting it now is also the right thing to do, it’s all about our assessment of fairness to the clients. But stock market notwithstanding, the economy is still improving; the capital markets are still generous, the suppliers of capital eager, the owners of assets are happy to hold.

And so, and there are no distressed sellers. So, there is really nothing to say that we’re in any kind of factitious environment for distressed supply. I accept that we still have these pockets that we signed and that we continue to mind, but of course we can only put so much money into each one without mis-diversifying the fund.

Michael Kim - Sandler O'Neill

Okay, that’s helpful. And then second, just assuming the equity markets continue to rally and pension plans continue to move closer to being fully funded broadly speaking, just curious to get your take on what any sort of implications might be for allocation or demand trends across different asset classes and specifically alternatives if any?

Howard Marks

Corporate plans are in a relatively healthy shape. I’ve [talked] to corporate plans in the last month; I visited with corporate plans last months that were a 190% and 113% funded. However, while some are doing what’s called the soft close, whereas no new employees can become members of the plans, not many have done hard closes, which is where the people already in the plan start accruing further benefits.

And as long as they do accrue further benefits, companies will have to earn returns at their actuarial assumption to pay those benefits and to remain fully funded. And for the most part those actuarial assumptions are about 7.50, 7.75. So, that’s a long way of saying they have to make 7.50, 7.75, how do you do that today? Bonds pay 2, 3, 4, high yield pay 6, most people think stocks will do 6 or 7 going forward. So, the answer is stocks and bonds are not the answer to making the actuarial assumption; they will need alternative investments.

It’s not a [hennery] pass, they will not invest for trouble. By the way, who will invest for trouble are the states that are 60 plus minus percent funded. So there will still be heavy demanders of alternative assets, whereas the corporate plans will only need them in the ordinary course of business. But I still think there is a strong need for our products. We continue to -- we and our brethren continue to perform in a superior way. And I am especially excited about this new suite of products we have to try to make roughly 10% net for our clients led by strategic credit, enhanced income, real estate debt, mezzanine and European dislocation.

And I think that a mix of those is a great product for a pension fund that has to still make money. And I think our clients are very receptive to that. So, the bottom-line if I wanted to giving a short answer, which is not my inclination is that even if you’re fully funded, you still have to make money.

Michael Kim - Sandler O'Neill

Okay. That’s helpful. Thanks for taking my questions.

Operator

Thank you. Our next question is from Chris Harris from Wells Fargo Securities.

Chris Harris - Wells Fargo Securities

Thanks guys. Just a question on your investment process, on the one hand with the growth in your step outs has been positive for a lot of reasons not to lease the rick that helps more growth, but on the other side of the equation as we think about it to some extent it creates a bit of risk for you because this has given a lot large numbers, it seems like you guys have so many more investment opportunities you’re looking at now it’s almost impossible to be as critic them in the same degree say if you’re running just one fund. So I guess what I’m asking is, how has your investment process changed as you guys significantly grow the business? And what can you do to make sure I should grow you maintain a really strong performance you’ve had historically?

Howard Marks

I think the answer is that the investment process has not changed and will not change. The vision you present is of me or Bruce Karsh or somebody like that sitting in his office and whereas he used to make two investments a week, he now makes 200 because we have twice as many strategies or something like that.

The truth is that each person’s workload has not increased and the process of running the distressed debt funds or the Principal Funds or the emerging market funds or the high yield bond funds has not changed. And Sheldon Stone has 140 names in his portfolio that he did 20 years ago and he still does today and so forth.

Each fund group is headed by a highly professional and highly experienced individual or duo that runs their own fund with considerable latitude. We do not have the essential investment committee that has to look at all the investments and by definition then is getting further from anyone of them. Everybody makes their own investments, it’s we’re decentralized, we have a delegation responsibility, everybody knows that if there is something they have a question about, they come to Bruce Karsh, if they wonder about whether it’s a good investment and they come to me if they have a question about suitability. But as long as -- so the risk we have is not a structure risk or process risk, it’s a manager risk. And we haven’t added a lot of people to the decision process. Most of the people we’ve added are people we know extremely well. And as long as we continue to add great people and attract and retain, then I think it’s not a risk.

John Frank

Howard, I’d just supplement that by pointing out Chris one of the things we’ve talked about in some of our prior calls, which is one of the things we really like about number of our new strategies is what they’re doing is taking advantage of opportunities. Again I think the premise as Howard suggested of your question was slightly off. A lot of what we are now investing in real-estate debt in European private debt or our dislocation front in our strategic credit fund, we are investing in securities on opportunities that we were already there, that we were already looking at but which we were concluding did not offer a sufficient return for our mainstream distressed strategy or for our opportunities real estate strategy.

But now instead of throwing them back in the proverbial pond, we have another place we can put them where we have a lower return threshold. So a lot of the work that’s been done is not in fact new work, it’s work that was already being but now it’s more productive.

Chris Harris - Wells Fargo

Helpful color, guys. Thank you.

Operator

Thank you. Our next question is from Brian Bedell from Deutsche Bank.

Brian Bedell - Deutsche Bank

Hi, good morning folks. If you can just elaborate a little bit more on some of the opportunities and more granularly in strategic credit given some of the rotation that we are seeing into more constraint credit type of products? And then John, you also mentioned the senior loan and high yield areas where you are managing 6.5 billion and 20 billion respectively in a marketplace that’s near 2 trillion. How quickly do you think you can scale your current expertise in those areas to grow over the next one to two years?

John Frank

Well with respect to the senior loans, I don’t think it’s candidly a question of scaling our expertise for our team. We’ve got a good team and we are adding to the team but we got a very strong team with Desmund Shirazi who has been with us since prior to the inception of Oaktree and a guy name Armen Panossian who has joined Desmund as a Co-Manager of that group who came out of our distressed group and has got strong credit skills. So we have a strong team. Now the question is how much money can we raise, how quickly and how responsibly can we deploy it.

It won’t shock any of you having listened to us over the last few years that our foremost concern is deploying the capital capably. And at this point we can probably raise capital more quickly than we would feel comfortable investing at. I was talking Armen yesterday morning at this very topic. And we’re going to continue to grow the strategy and obviously we would like to grow it as much as we can but the foremost priority is to do a good job with investing the money. So I think we can grow the strategy significantly over the next few years. I don’t know we more than doubled last year or we put it rough by 67%, I guess was -- 76% last year.

And I think I am not really doing this on any arithmetic basis, but I am sure we can see again very substantial growth this year. But as I say, I think we -- I mentioned on the call, we’ve just launched our newest enhanced income fund. We have very, very strong response to that and my guess is we are going to end up turning away capital not because we wouldn’t love to manage more capital but because we want to make sure we do a good job of it.

So I think we will grow the strategy consistently over time but we are not going to sacrifice performance just try to grow it. Now as for strategic credit, Howard, do you want to address that or would you like me to?

Howard Marks

No, I mean we formed strategic credit a year and half ago around Edgar Lee who is one of the bright young guys in Bruce’s distress debt group, and I think that the performance to-date on a modest amount of money speaks for itself, 18% last year before fees. We all think that Edgar is a bright guy, will give them the necessary resources; will be judicious about the money. The point is that the fund -- the strategy is targeted to try to make 10; last year -- 10 net, last year we made 18 gross because of the search for yield and assets were appreciating. We don’t project that but we’re talking to 10 and people will invest for the 10. And let me say one thing before I forget which I couldn’t use in my answer to the last question. One of the things if you read our business philosophy, one of the things which is explicitly rejected is making money by skimping on costs. And we believe in fully staffing our investment activities with really smart people. We care a hell of a lot more than you do that our reputation remains intact, it’s all we have.

And so to return to strategic credits for a minute, I have been thinking lately in terms of the various kinds of risk there are. There is data risk in correlation that is risk related to the market; there is manager risk which is that you have the wrong guy or it goes through a period of bad judgment; there is a leverage risk which is self explanatory I think; there are a variety of kinds of -- and there is fundamental risk which is to say are the assets -- risky assets, high quality assets or low quality assets. And if you look at EIF where we have high quality assets run by somebody who is highly experienced in a field where the market really kind of dominates the returns and loans are up 5% if you are up 6% is a greatest thing in the history, there we have primarily leverage risk. You move over the strategic credit where we are going for the same absolute return and we think the risks are comparable in magnitude.

Here we don’t have any leverage but here we have lower quality assets and substantial manager risk because we are making bigger bets on individual assets which are less homogeneous. So, it’s clear that there is manager risk in strategic credits. We've made a bet on Edgar in this case and if it turns out to be a good bet then the strategy succeeds and if not it doesn’t, but this is what we've always done. That same analysis was true when Sheldon and I, Sheldon had been running the high yield bond, which was a diversified low manager risks situation and we candid the rains to Bruce Karsh of the distressed debt funds, which is a less diversified lower quality asset, highly manager and alpha intensive strategy. I think we’re used of thinking about these things and being careful and making good decisions.

Brian Bedell - Deutsche Bank

Great, that's very helpful. And then maybe just, John, you mentioned new mutual fund product, I think it was in the conversation about the sub-advisory mandates. Maybe just if you can elaborate on, I guess sort of intermediate term whether there is plan to launch individual products and what type of distribution channel would you target at that? And then longer term as you think about the business mix, we moved little bit more towards open-end products over the last couple of years versus closed-end product a function of Opps VIIb going down. But if you think about longer term strategically say over the next three to five years, do you envision Oaktree becoming moving into more traditional products from a business mix perspective versus the other closed-end funds?

John Frank

Thanks Brian. With respect to the mutual funds, we are -- let me talk about that for a second in that sort of more general and less granular way. We’ve talked in a number of these calls about the fact that expanding our distribution of our products is important to us. And we’re exploring that in number of different ways, both selling our existing products through new channels and thinking about the development of channels that we can exploit or we can access that we haven’t before.

Now with respect to the mutual funds, we have products like high yield and convertibles obviously we can do in a mutual fund format and others, which we think there are opportunities to access new markets, so we’re pursuing that. One of the things that we’ve talked about that we’re very, very conscious of and Howard alluded to, when he was talking about the corporate pension plans, obviously our bread and butter is corporate and state pension plans -- funds et cetera.

We are like others like our brethren as Howard referred to them are looking for ways to get into the defined contribution market. In order to do so you have to have products at least on the today’s regulatory environment that have daily liquidity. So, we’re thinking about the kinds of strategies we have, we’ve got established records, we have a established expertise and how we can package them in a way that would be accessible to different sorts of clients different sorts of distribution channels including the define contribution business.

So, that’s something you’ll continue to hear from us about over the next months and years. I’ve now forgotten the second part of your question. You asked about mutual funds and what was the other?

Brian Bedell - Deutsche Bank

Yes. The longer term nature, I guess as you strips that out…

John Frank

The mix of our business and you talked about the fact to become a little more open-end focus little less closed-end focus you are right part of that is simply a function of the fact we had distressed fund that’s come down in size. One of the things to think about, which we think is an advantage going forward as we think about of our business is, some of our new products, the closed-end funds were terrific, they have a carry, you locked up money that a high management fee one of the not great parts about the closed-end business is you end up distributing money and we have distributed $44 billion over the last few years.

So, you’ve got to constantly distribute and raise money. A lot of the new money that we are raising is more evergreen in nature. On the one hand the client has the contractual right to remove it with relatively little notice, on the other hand our experience has been and in the case of high yield clients have the right to remove that money on 30 days notice. But our experience has been tend to be very, very sticky, it does not tend to be removed from our management very quickly.

So, a lot of the new money that we’re raising in these new strategies, we think we’ll be sticky and we will continually reinvest the investment gains that we make. So, that will be a very attractive diversifier we think for our business going forward.

The other thing is a number of these new strategies are price-based on NAV. And again as markets rise as we do a good job, the value of those accounts will increase and our management fees will increase. So, I have given you a very, very long answer, but if you were to summarize that I think what I would say is I think the increasing diversification of our fee streams, the increasing diversification of the different ways we repaid, the different formats that we are managing money for clients is all going to be very beneficial going forward.

Brian Bedell - Deutsche Bank

Yes. And I would just add, it seems like your ability to grow the fee-based part of the business versus the carrier-based part of the business is strong given the new products and the new distribution channels that you’ve been talking about. That’s great. Thanks so much for taking my questions.

John Frank

Thanks Brian.

Operator

Thank you. Our next question is from Ken Worthington from JP Morgan.

Ken Worthington - JP Morgan

Hi, good afternoon here. Just on the AUM side what kind of investments are you making to build out those capabilities? I guess the question is, are you managing with the existing infrastructure or are you opening up your loss series are you hiring locals to have boots on the ground in those regions for these new products or are you kind of managing out of your existing infrastructure that’s already been dumped out?

John Frank

Hey Ken, it’s…go ahead Howard.

Howard Marks

Well, I just want to say that we’ve had boots on the ground with offices in Singapore and Hong Kong since 1998 doing this function at the end of 98 when we organized our first few merchant markets after return to that. And so, we are well staffed and the money is run by the team in Singapore and Hong Kong and Stanford. And we will expand the headcount as we need to, but the infrastructure does not have to be created they know well.

Ken Worthington - JP Morgan

Okay, perfect. And then on the investment side of the equation, so it looks like Fund IX invested a lot, how much is invested during the quarter, I didn’t have a chance to back into it yet? And maybe talk about the quality of the investments that you are seeing, you mentioned I think Howard in the beginning that it was a good equity market fund environment and kind of risk off, you’re talking about kind of real estate and shipping as broader based opportunities that you are seeing, maybe what were the themes that were driving where you put money to work during the quarter?

John Frank

Well, I actually think it was a risk on environment, most people are more comfortable with risk…

Ken Worthington - JP Morgan

That risk…

Howard Marks

Yes, okay. And are taking more of it. Our group is very selective, the last thing that I’ll ever do is lower their standards. Having said that, our return expectations are quite modest today. So, we are not going to take higher risk to get the old returns, we are going to take same risk to get and settle for less return.

So, we are trying to get 15% gross and it’s a challenge in these markets. And we have been investing for example in shipping which is one of the big areas the two years, but we have a lot of money in shipping and there are areas where day rates have doubled in the last year and prices are up 20% for vessels and so forth.

As I said in my remarks, we like to buy them when people say no way. And not as many people are saying no way as (inaudible) today. So we are still making some investments but carefully and not as aggressively and less.

Real estate is an area where we can still get flow both debt and bricks and mortar. And we continue to invest. So it’s hard to generalize, let me say that in our business like probably the other people you follow, we have three basic jobs, we have to raise money, invested well and divested at the right time hopefully depreciates.

And if you think about those last two chores, it’s unlikely that we can do both really well at the same time. And today -- this is a time for harvesting. And we've been harvesting a great amount and we've been investing slowly and carefully in smaller amounts. Now, we are lucky to be active in fields like emerging markets and non-prime real estate for example, where the flow of money has not been as strong as it has been into some of the more mainstream and public markets.

And so we think we can still get some good deals, but this is not the climate that a bargain hunt or dreams of, I can assure you.

Ken Worthington - JP Morgan

Great. Thank you very much.

Operator

Thank you. And our final question today is from Danielle Matsumoto from Goldman Sachs.

Danielle Matsumoto - Goldman Sachs

Great, thanks. This is Danielle Matsumoto from Marc Irizarry’s team here at Goldman. I just wanted to get a little bit more color on the strategic rationale behind the Cinda investment. What should we expect from here out of that partnership and what's your vision and also would you do anymore deals like this if they were to come across on the table? Thank you.

John Frank

Hey Danielle. So, most of you know that Cinda, which recently did its IPO in December is one of the leading distressed asset managers in China. That huge corporation has 18,000 employees. We've announced our mutual intent to create a joint venture. What we have in mind is that we will invest perhaps upto $1 billion, half from Cinda, half from our existing funds in investments that we each approve. In terms of the strategic rationale, we were enormously attracted to the opportunity to work with Cinda, there is no question who is the leading distressed real-estate investor in China and obviously their knowledge of the market and their expertise in China is peerless. At the same time, I think that they were attracted to our experience and expertise in distressed debt worldwide and a very long tenure.

So for us it’s an opportunity Danielle to learn more about China to invest shoulder-to-shoulder with probably the entity in China that is best positioned to invest in distressed assets, particularly distressed real-estate assets. So that’s obviously appealing to us. If we have -- it’s as I said in my prepared remarks very early to know how this will work out. Our colleague is Beijing right now talking with Cinda about the details. But if it works as we hope, we’ll learn a lot and hopefully we’ll be the partner to Cinda as well. If we have the opportunity to do that with other firms either in China or elsewhere, we absolutely would be delighted. But as I say, it’s a work in process, we’ll see how it goes, but we’re optimistic and very excited.

Danielle Matsumoto - Goldman Sachs

Great, thanks. And then just one last one, it seems like there are a lot of incentives created in the quarter and it seems like there is more upside than maybe the market often appreciates. So could you give an update on how much equity exposure there is in Fund VIIb and maybe some of the other opportunities and principle of closed end fund?

David Kirchheimer

Sure. So, out of the accrued incentives balance and by the way, I happen to agree whole heartedly with your promise Danielle. Out of the accrued incentives balance, about 60% was in equities as of year-end 2013. And so that’s a natural reflection of what Howard mentioned in his remarks which is the conversion of debt into equity. And specific to VIIB, let’s see, there we’ve got again that sort of parallels that percentage; it’s a slightly below 60%. And so, quite excited about the continued upside in addition to the equity, I would just reference back my comment about the continued interest income on the debt side of that portfolio as well, both VIIB and the total accrued incentives. And by the way this is also an opportunity for me to say that there was a fund I hope where look when Matt asked the question earlier about funds that are getting closer to moving into the paying incentives mode and that’s European Principal Fund as you can see in the fund table. So yes, we are quite excited about the continued upside there.

Danielle Matsumoto - Goldman Sachs

Okay, thanks very much.

John Frank

Thanks Danielle.

Andrea Williams

Thank you again for joining us for our fourth quarter 2013 earnings conference call. A reply of this conference call will be available for 30 days on Oaktree’s website in the Unitholders section or by dialing 800-677-5211 in the U.S. or 1402-998-1032 outside of the U.S. That replay will begin approximately one hour after this broadcast. Thank you.

Operator

Thank you. And this does conclude today’s conference. You may disconnect at this time.

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